The difference between employment and dividends

By Max Newnham

11 June 2018 — 11:14am

The task of choosing the best structure to own and operate a business through is made harder because of the different tax treatment relating to each structure. If a business has a high likelihood of being sold at a profit due to an increase in the value of goodwill, a company is the worst entity to choose.

When a business is owned and operated either through a discretionary family trust or as a sole trader or a partnership of individuals, the owners benefit from all of the small business capital gains tax (CGT) concessions. When a business is owned by company, the owners do not benefit from the 50 per cent general CGT discount, and in effect get no benefit from the 50 per cent active asset discount.

By allowing small business entity companies to access all of the CGT concessions, one of the biggest disadvantages of using a company would be removed.

Photo: Louie Douvis

If the coalition government was truly interested in providing lasting tax benefits to the small business sector, and the Labor party wanted to crack down on their perceived rorting of the tax system by the use of discretionary family trusts, they should have bipartisan agreement to change the CGT laws to allow shareholders of small business entity CGT companies to access the same tax benefits as individuals and family trusts.

This benefit would apply, unless there was an increase in the current turnover limit, only to companies that passed the relevant small business CGT concession tests.

By allowing small business entity companies to access all of the CGT concessions, one of the biggest disadvantages of using a company would be removed. The other, more restrictive, tax rules that apply to companies would still be in place, ensuring the integrity of the income tax system was preserved.

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Q. I run a small family business through a company, of which I own 100 per cent of the shares and am a joint director with my wife. Can I pay my wife a dividend, which she then declares as income and claims an imputation tax credit for? If this is possible, do both directors need to formally approve such a payment or can I as the sole owner of the business authorise it?

A. When a business is operated through a company, there is a clear distinction between what owners can be paid and what employees can be paid. Only the shareholders of a company are entitled to receive income in the form of dividends - anyone working for the company can be paid salaries or wages for which the company receives a tax deduction.

If your aim is to decrease the taxable income of the company, rather than paying a dividend to your wife, you will need to complete the paperwork required to show she is an employee of the company.

If you paid her without her being an employee, this would be regarded as a shareholder loan, which would either be classed as an unfranked dividend paid to you that would be taxable in your hands, or treated as a shareholder loan that must be repaid within seven years.

Max Newnham is a partner in TaxBiz Australia and founder of SMSF Survival Centre.